If a $3,000 contribution to your individual retirement account
(IRA) is good tax and retirement planning, then $4,000 should be
even better, right? Sure, if you enjoy paying penalties.
If a $3,000 contribution to your individual retirement account (IRA) is good tax and retirement planning, then $4,000 should be even better, right? Sure, if you enjoy paying penalties.
Each year, your combined contributions to all IRAs cannot exceed $3,000, regardless of the number or type you own. That limit increases to $3,500 if you’re 50 or older.
Even a $3,000 contribution may exceed your maximum and incur penalties, based on your income. If your compensation or earned income is below $3,000, your maximum contribution is limited to that lower amount. Also, your allowable contribution may be phased out when your income exceeds a certain threshold.
Unless removed by the due date of your tax return (including extensions), contributions over your limit are subject to a 6% penalty. Any earnings on the excess contribution must also be removed, and if this results in income on your tax return, a 10% early withdrawal penalty may apply.
The 6% excess contribution penalty applies to all future years until a corrective distribution is taken. You can also reduce or eliminate an excess contribution by forgoing all or part of your allowable IRA contribution in future years.
Assume you are eligible to contribute $3,000 to your IRAs in 2004. If you contribute $4,000 and don’t take a corrective distribution, the excess $1,000 is subject to the 6% penalty. During the next year, you make no contribution, but are eligible to do so. You can apply the $1,000 excess contribution from 2004 to 2005, and no penalty will be due for 2005.
IRAs are a great planning tool, but excess contribution penalties can quickly eliminate their tax advantage. Contribution rules can be complex, so it is often best to seek professional assistance. For details or assistance, give us a call.
Robert Bianchi is a CPA with Bianchi Lorincz & Co. in downtown Hollister. He can be reached at 638-2111.
